MUNICIPAL BUDGETS HINGE ON
PENSION RETURNS

Bad outcomes — like S.D.’s last year — can cost taxpayers millions

Impact of lower return

The past decade of dismal returns — 5.7 percent over the past 10 years for pension plans, according to the National Association of Retirement Administrators — has given many pause.

Matthew Glans, a senior policy analyst at The Heartland Institute, a Chicago-based nonprofit research group that advocates for free-market solutions, said there’s no silver bullet for where the assumed rate of return should be set but he considers a good baseline to be the rate offered on 15-year Treasury bonds of about 3 to 3.5 percent.

Glans acknowledged that lowering rates to such extremes would be difficult but said it gives a more realistic view of the nation’s pension woes.

“Decreasing the expected rate of return does have consequences,” he said. “By lowering the assumed rate of return, which is used to determine the present value of benefits which will be paid to retired workers in the future, pension fund regulators will increase the apparent level of obligations. While this does increase liabilities, it informs those responsible for managing the fund about the real problems the pension fund faces.”

Conversely, if the assumed rate is set higher, to say 10 percent, pension obligations would appear to diminish, but the likelihood of reaching that goal would be scant. It would mask the depth of the pension debt.

Chris Cate, vice president of the San Diego County Taxpayers Association, called it a balancing act to determine what the appropriate rate is for each public agency because setting it too high or too low can lead to severe budgetary consequences.

“The problem with these high assumed rate of returns is that if they don’t come in taxpayers are on the hook for paying the bulk of those losses,” he said. “ … Someone is eventually going to have to make that leap of faith and be the first to drop it down to a rate … where it’s a little bit more of a realistic rate of return. Who should make that first step?”

Slightly lower return goal

The city of San Diego’s pension system has lowered its rate twice in the past four years, from 8 percent to 7.75 percent to 7.5 percent.

Mark Hovey, chief executive of the San Diego City Employees’ Retirement System, said the changes were made based on the growing consensus in the financial world that 8 percent returns are becoming less likely and on the desire by pension boards to reduce the amount of risk the system takes on. He said it’s still reasonable to assume returns above 7 percent.

“History says we’ve done it,” Hovey said. “Our investment consultants say we’re likely to continue doing it. Public-sector pension plans are working with plan sponsors that aren’t going out of business. So you don’t have the same degree of risk that’s involved in a corporate sector plan.”

Hovey said a city official once asked him what would happen if the rate were 5 percent.

He explained the annual pension payment would probably increase by $100 million. That ended the discussion.